Tuesday, September 1, 2009

You are Leaving Your Children the Husk: Politics, Debt Addiction and American Decline

I just had a long conversation with a friend in my neighborhood, Ulster County, New York. My friend owns a construction company that specializes in high-end residences. She advocates hyper-inflation and low taxes. The connection between her business and inflation is that debt is necessary to stimulate purchases of expensive houses. Monetary expansion is one and the same thing as debt expansion. The Federal Reserve Bank expands the money supply by increasing bank reserves (i.e., by purchasing government bonds from banks and depositing artificially created dollars in the banks). The banks lend out a multiple of the reserves, increasing the money supply. The new debt is used to build expensive houses, but the purchases of the materials for the new houses increases prices. Increasing prices spread through the economy as suppliers of suppliers face increased demand. The result is higher prices at the supermarket, and widespread wealth reduction for anyone who buys consumer goods. Inflation is thus a tax on all Americans in the interest of specific businesses and government that depend on debt. The biggest debtors are of course big, not small business. Examples are hedge funds and Wall Street. Government is the biggest debtor of all. Direct taxation "crowds out" spending on personal consumption in favor of the black hole of government waste. Inflation allocates consumption to the wealthy who can afford to borrow for expensive houses at the expense of those who buy at the supermarket check out.

The use of monetary expansion stimulates businesses that require debt at the expense of those that do not. Thus, expensive, big ticket items such as automobiles and houses are emphasized at the expense of smaller ticket items that you might purchase at a local fair, a supermarket or a boutique. Innovation of new technology that would not depend on debt for demand is replaced by real estate, investment and luxury markets. Returns to innovation become smaller in comparison with subsidized interests such as hedge funds. Income inequality results when merchandise that requires good credit is subsidized and risky innovation is discouraged. Things that people really need are not produced and instead things for which debt is available are produced. Inefficient businesses that do not reflect neutral demand but rather artificially induced demand are encouraged. Special interests accumulate that demand greater inflation. My friend, for instance, has invested in a construction company that depends on inflation. If inflation were to end, she would be ruined. Thus vested special interests that demand ever greater misallocation accumulate. Funds available for innovation diminish. The economy becomes rigidly committed to construction, real estate and automobiles, forgetting that but 15 decades ago suburbs and automobiles did not exist at all, and only came into being because of unpredictable, spontaneous innovation that social democracy has aimed to destroy since the days of Walter Weyl.

One of the effects of social democratic monetary expansion is to reduce demand for labor as debt for capital investment is made artificially available. Labor-saving machinery is made more readily available because interest rates are low. Therefore, demand for labor in capital intensive industries becomes weaker, resulting in stagnant wages. Also, expensive plant relocations to low wage nations are facilitated by low interest rates. Plant relocation is also a form of capital investment that artificially low interest rates stimulate.

There is considerable mal-investment in the American economy. My friend's construction firm is an example. Expensive house building is subsidized by low-wage consumers. The resources that could have gone into innovation and the creation of jobs to manufacture new products instead subsidizes expensive house building. There is only marginal demand for the expensive houses, so ever lower interest rates are needed to stimulate ever greater amounts of house building.

The same is true of Wall Street investments, hedge funds, and corporate takeovers. Printed money is made available to these special interests, who enjoy profits and a rising market as demand is initially stimulated through artificially low interest rates. The general public pays a tax to the wealthy via the Federal Reserve.

This system of allocation of wealth to wealthy interests is the product of the Democratic Party, specifically Woodrow Wilson, who oversaw establishment of the Federal Reserve Bank in 1913 and Franklin D. Roosevelt, who first abolished the gold standard in the early 1930s. However, the Republicans have also played an active role in establishing this system. President Richard M. Nixon abolished the gold standard in 1971 and Presidents Nixon, Reagan and Bush were aggressive inflationists.

Both parties, Democratic and Republican, are big government, interventionist parties. Both favor monetary creation to subsidize special interests. Both have favored Wall Street, commercial banking and corporate interests.

The problem with allocating wealth to special interests is that less productive investments are pursued at the expense of more productive. As less efficient firms accumulate, from Wall Street firms to real estate construction, waste becomes greater. The nation's wealth is extracted and new, innovative ways of using wealth are neglected because the rewards from innovation are diminished while the rewards of wealth extraction by banking, law and investment interests are expanded. Government work is subsidized while the work of factory supervisors and inventors is diminished. As wealth is squandered, the nation becomes poorer.

One of the ironic effects of this process is that the stimulated industries tend to be harmful to the environment. Thus, suburbs were created by Federal Reserve financed construction that far exceeded the demand that would have existed without subsidies from poorer Americans to suburban borrowers. The effect is enhanced use of the automobile, ever greater commutes and worse pollution.

As resources are squandered the technological model which utilizes them becomes exhausted. Innovation has been squelched so new technological advance does not occur. The result is national decline, stagnant or declining real hourly wages and declining opportunities for future generations.

The Federal Reserve Bank is impoverishing your children. But the interests who benefit are palpable, while the interests that are harmed, those who would benefit from unknown invention that would have occurred in the absence of the subsidies, cannot be identified. Public employees know who they are and form a powerful lobby. Beneficiaries of a yet-unknown cure for cancer or a new form of transportation are not known to themselves or anyone else.

This system is leaving future generations a husk. It is eating the corn without planting for the future. It is a reactionary, declining system.

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Mitchell Langbert

About Me

I have researched and written about employee benefit issues and in my previous life was a corporate benefits administrator. I am currently associate professor of business at Brooklyn College. I hold a Ph.D. from the Columbia University Graduate School of Business, an MBA from UCLA and an AB from Sarah Lawrence College. I am working on a project involving public policy. I blog on academic and political topics.